My kid is in college and because of scholarships and other money we will have more funds in the 529 plan than are strictly needed for qualified withdrawals.
When withdrawing from a 529 there are three types of withdrawals:
Qualified - no taxes, no penalty. Used for tuition, books, etc.
Penalty free - You pay taxes, but no penalty. Used to offset things like scholarships.
Penalized - You pay taxes and a 10% fee on earnings. Money not used for qualified expenses and not offset by scholarships or other awards.
He was given a partial scholarship so I know I can withdraw some of the money penalty free (no 10% penalty, just taxes) against the scholarship.
He was also given credit on his housing for being a resident advisor. I don’t know if that credit can be withdrawn against penalty free. I’ve looked in the IRS code https://www.irs.gov/pub/irs-pdf/p970.pdf and in there it says, “Exceptions.
The 10% additional tax doesn’t apply to the following distributions…
d. Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.”
I can easily see this credit as being a tax free payment received as educational assistance.
Anyone have any thoughts on where I go to find a definitive answer?
We also have more in our 529s than our son might use, but we are going to leave it there since he may go to grad school or take some other educational course. It can also be transferred between family members, so I could take cooking or real estate classes, and the 529 would pay.
Definitive answers for this kind of thing are hard to come by–there are just opinions. In the end, the only opinion that matters is that of the IRS agent who audits your account. The 529 withdrawals depend on voluntary compliance (like filing your income tax). You do not have to provide any documentation at the time of your withdrawals; the IRS will never see an accounting of why you made which withdrawals unless you are audited.
The most definitive answer you could get would be from the IRS themselves. Try calling them. But be aware that the answer you get from a phone rep could be different than what an auditor would say later, and then it won’t matter what the person on the phone told you.
Another thing you could do is ask a tax attorney who may have personally seen many such cases audited and resolved.
(BTW I have two 529 accounts for my two kids, who are both current in college, although my situation is much more straightforward so I have not personally grappled with your situation.)
I’ve considered just letting the money sit for a while and seeing if any of his siblings decide to head to grad school. If that happens I’d definitely need the money. I’ve also considered transferring it to nieces or nephews.
I might seek out a tax attorney and see what they say. It would probably be worth the $200 just to get a better feel for how much risk I’d be taking if I withdraw the money as non-qualified (non-penalized).
Grad school depends on what they’re currently studying. If it’s something e.g. STEM then grad school should be mostly subsidized by them working as a TA/RA, and thus not cost much. If their grad school in one of these cases is not willing to pay for a significant portion of their tuition, then they need to find a new grad school.
Do you already have an accountant? A EA or CPA would handle this, you shouldn’t need a JD.
While the Auditor’s answer is the final one (unless it goes to court), if you can show that you based your actions on an advisory opinion from any IRS agent, that will help. It will be treated as an inadvertent mistake, rather than any attempt to avoid taxes. So you won’t face any fines or penalties; you just have to pay the tax you owe plus interest. (And you might even get them to waive part of the interest.) So maybe some help.
I do this kind of research for people at work occasionally, so my advice is to hire a CPA or Enrolled Agent to find out the answer for you. They should have access to better sources of research than those publicly available. There might be a college tax library at a local school that has all those sources of information on dead trees that the public can browse on site, but good luck knowing where to look and how to find anything without actually having done anything like it before.